Signs of the Economic Apocalypse, 9-8-08

From SOTT.net:

Gold closed at 802.80 dollars an ounce Friday, down 4.1% from $835.20 for the week. The dollar closed at 0.7009 euros Friday, up 2.8% from 0.6815 at the close of the previous week. That put the euro at 1.4267 dollars compared to 1.4674 the week before. Gold in euros would be 562.70 euros an ounce, down 1.1% from 569.17 at the close of the previous Friday. Oil closed at 106.23 dollars a barrel Friday, down 8.7% from $115.46 at the end of the week before. Oil in euros would be 74.46 euros a barrel, down 5.7% from 78.68 for the week. The gold/oil ratio closed at 7.56, up 4.6% from 7.23 at the end of the week before. In U.S. stocks, the Dow closed at 11,220.96 Friday, down 2.9% from 11,543.55 at the close of the previous Friday. The NASDAQ closed at 2,255.88 Friday, down 4.9% from 2,367.52 at the close of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 3.70%, down 11 basis points from 3.81 for the week.

Signs of an economic collapse began to pile up again last week, leading to further drops in commodity prices. Oil fell almost 9% and gold fell 4%. The dollar continued to rise against the euro. Job losses continued in the United States and now 9% of houses in the U.S. are behind in payments or in foreclosure. Finally, the U.S. government seized Fannie Mae and Freddie Mac.

US jobless rate soars as foreclosures break new record

Bill Van Auken

6 September 2008

In a stark indication that the crises gripping the US housing market and the financial sector are spreading throughout the economy, unemployment figures for August rose far more sharply than expected, hitting a five-year high.

The official unemployment rate rose to 6.1 percent last month, according to a report released Friday by the Bureau of Labor Statistics. In addition to the net loss of 84,000 jobs last month, the agency revised its figures for June and July, reporting the destruction of an additional 58,000 jobs, pointing to an entire summer dominated by layoffs and economic slump.

Meanwhile the so-called misery index, which adds the unemployment and inflation rates, hit 11.7 percent, the worst figure recorded since mid-1991, as high gas, food and utility prices continue to gouge workers’ paychecks even as layoffs mount.

Also on Friday, the Mortgage Bankers Association issued a report showing that the new foreclosure rate has risen to its highest point in nearly three decades, as falling home prices and tighter credit is forcing more and more people out of their homes. The total number of homes in foreclosure hit 2.75 percent, triple the rate recorded three years ago. Meanwhile, 6.41 percent of all home mortgages were one or more payments overdue, a record high since these figures were first recorded in 1979.

At the same time, existing home sales fell to a 10-year low in the second quarter, while the median price of a single-family house plummeted by another 7.6 percent, the National Association of Realtors reported.

The increase in unemployment and the rising number of foreclosures are clearly trends that are feeding into one another in a vicious downward spiral. Workers having lost their jobs are finding it impossible to meet monthly mortgage payments, and the collapse of home values has wiped out credit for many, leading to falling consumption and new layoffs.

The loss of jobs was spread throughout the economy, with health care, education and government employment virtually alone in resisting the surge of layoffs. Manufacturing companies cut 61,000 workers from their payrolls; business and professional companies eliminated 53,000 jobs, temporary employment—which generally is a leading indicator of future job trends—fell by 36,000 and the retail trade sector cut 19,900 jobs. Construction employment was down just 8,000, reflecting in part the massive bloodletting that has already taken place—558,000 jobs wiped out since the beginning of 2007.

Massive new layoffs are on the horizon. The Air Transport Association reported Friday that US airlines plan to cut at least 36,000 jobs by the end of the year.
Job cuts will continue throughout the auto industry as new vehicle sales slump. The DMAX engine plant in Dayton, Ohio announced this week that it is laying off another 330 workers, on top of 290 jobs cut in July. The plant makes engines for GM trucks. Daimler Trucks North America, meanwhile, has announced plans to cut one of the two shifts at its Mount Holly, North Carolina Freightliner plant, putting 675 workers on the unemployment lines.

The financial sector is also shedding large numbers of jobs. GMAC Financial Services announced this week it will lay off 5,000 workers, while Wachovia Corp. has indicated that it intends to eliminate the jobs of some 7,000 of its employees.

The official figures released Friday were substantially higher than those predicted by economists, who had projected only a 0.1 percent increase over July’s rate of 5.7 percent, with the loss of 75,000 jobs, rather than a 0.4 jump to 6.1 percent and the loss of 84,000 jobs.

The decisive issue in the unemployment figures is the sustained character of the assault on jobs, with unemployment rising for eight months straight—the most protracted such trend in the last 25 years. The result is that 2.2 million more workers have joined the unemployment lines over the past year, for a total of 9.4 million officially counted as out of work.

These figures drastically underestimate the real crisis confronting working people in the US. An alternative measure provided by the Bureau of Labor Statistics, which includes so-called “discouraged workers”—those who have given up actively looking for work—as well as those forced to eke out a living with part-time jobs because they are unable to get full-time work, rose by a tenth of a percentage point to account for fully 10.7 percent of the US workforce.

The latest report on the growth in unemployment elicited widespread acknowledgment that the US economy is gripped by recession.

“The economy has clearly slipped into a jobs recession because the housing meltdown and credit market turmoil has spread to the broader economy,” Steven Wood, chief economist at Insight Economics, wrote after the new figures were released.

Bank of America economist Peter Kretzmer, in a note to investors, wrote, “The rapid rise in the unemployment rate points to a US recession, as such an increase has never occurred outside of one.” The economist said that household surveys have produced data indicating that 1.75 million jobs have been wiped out since April alone.

William Poole, former president of the Federal Reserve Bank of St. Louis, told Bloomberg Television, “It certainly increases the probability that we really are in a recession. It is a weak number, including the [June, July] revisions.”

Friday’s dismal unemployment and foreclosure figures came at the end of the worst week for the world financial markets since the aftermath of the terrorist attacks on New York City and Washington seven years ago.

The Dow Jones Industrial average eked out a 32-point advance Friday after falling nearly 350 points, or 3 percent, the day before—the worst losses in two months. The sell-off was attributed to the release of the initial projection of a 5.7 percent unemployment rate, combined with dismal retail sales figures and rampant rumors that a major hedge fund, Atticus Capital, with $14 billion in investments, was on the brink of collapse.

While the Atticus executives insisted that the rumors were false and that the fund had substantial cash reserves, the fears that major hedge funds will go under are well founded. Many of them had invested heavily in the commodity bubble, which has been rapidly deflating with the recent fall in oil and food prices.
Asian stock markets, which fell every day this week, suffered sharp losses Friday, with the Hang Seng index in Hong Kong falling 2.2 percent, Tokyo’s Nikei down 2.75 percent, the Shanghai A-share market dropping 3.3 percent and Australia’s market down 2.1 percent. Similar percentage losses were recorded on all of the major European markets.

Meanwhile, the manager of the world’s largest bond fund warned Friday that the US economy faced a “financial tsunami” unless the government intervenes to buy up assets being dumped by banks and finance houses.

“Unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami,” Bill Gross of California-based Pacific Investment Management Co. wrote in a statement on the company’s web site. “If we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the US Treasury.” Specifically, he called for the federal government to stem the foreclosure tide by issuing subsidized loans and buying up properties.

Gross’s statement reflects growing fears within financial circles that the worst of the credit crisis is still to come and could produce a catastrophic global collapse.

In the face of the rapidly deepening economic crisis, the White House issued a sanguine statement that simply ignored the job losses and rise in foreclosures, pointing instead to earlier figures showing an increase in the gross domestic product. “The level of growth demonstrates the resilience of the economy in the face of high energy prices, a weak housing market and difficulties in the financial markets,” the White House said.

While this is obviously cold comfort to the millions forced onto the unemployment lines or facing the loss of their homes, the attempt by the candidates of the two major parties to turn the latest figures into political hay offered little more.

Republican candidate John McCain acknowledged that “Americans are hurting and we must act to create jobs.” He vowed to enact a “Jobs for America” program, which appeared to involve little more than job training schemes, tax cuts for business and advocacy of free trade.

Democratic candidate Barack Obama issued a predictable statement accusing his rival McCain of preparing “more of the same” and continuing the Bush administration’s tax cuts for the rich. He pledged instead to institute an exceedingly modest tax cut for “middle-class families” plus a $50 billion fund to aid state budgets.

There is no reason to believe such paltry promises will be realized. Even they were, they would prove entirely inadequate to stem the tide of layoffs or stabilize the crisis-ridden financial system. The Democratic Party is incapable of advancing any serious alternative to the policies of the Bush administration, tied as it is to the interests of Wall Street and corporate America.

The continuing housing crisis led the U.S. government to take over the two Government Sponsored Enterprises, Fannie Mae and Freddie Mac in order to prevent a collapse of the world financial system.

Officials announce takeover of mortgage giants

September 7, 2008

Alan Zibel and Martin Crutsinger

WASHINGTON (AP) -- The Bush administration, acting to avert the potential for major financial turmoil, announced Sunday that the federal government was taking control of mortgage giants Fannie Mae and Freddie Mac.

Officials announced that the executives and board of directors of both institutions had been replaced. Herb Allison, a former vice chairman of Merrill Lynch, was selected to head Fannie Mae, and David Moffett, a former vice chairman of US Bancorp, was picked to head Freddie Mac.

Treasury Secretary Henry Paulson says the historic actions were being taken because "Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe."

The huge potential liabilities facing each company, as a result of soaring mortgage defaults, could cost taxpayers tens of billions of dollars, but Paulson stressed that the financial impacts if the two companies had been allowed to fail would be far more serious.

"A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance," Paulson said.

Both companies were placed into a government conservatorship that will be run by the Federal Housing Finance Agency, the new agency created by Congress this summer to regulate Fannie and Freddie.

The Federal Reserve and other federal banking regulators said in a joint statement Sunday that "a limited number of smaller institutions" have significant holdings of common or preferred stock shares in Fannie and Freddie, and that regulators were "prepared to work with these institutions to develop capital-restoration plans."

The two companies had nearly $36 billion in preferred shares outstanding as of June 30, according to filings with the Securities and Exchange Commission.
Paulson said that it would be up to Congress and the next president to figure out the two companies' ultimate structure.

"There is a consensus today ... that they cannot continue in their current form," he said.

Paulson and James Lockhart, director of the Federal Housing Finance Agency, stressed that their actions were designed to strengthen the role of the two mortgage giants in supporting the nation's housing market. Both companies do that by buying mortgage loans from banks and packaging those loans into securities that they either hold or sell to U.S. and foreign investors.

The companies own or guarantee about $5 trillion in home loans, about half the nation's total.

Lockhart said that both Fannie and Freddie would be allowed to increase the size of their holdings of mortgage-backed securities to bolster the housing industry as it undergoes its worst downturn in decades.

Lockhart said in order to conserve about $2 billion in capital the dividend payments on both common and preferred stock would be eliminated. He said that all lobbying activities of both companies would stop immediately. Both companies over the years made extensive efforts to lobby members of Congress in an effort to keep the benefits they enjoyed as government-sponsored enterprises.

Both Paulson and Lockhart were careful not to blame Daniel Mudd, the CEO of Fannie Mae, or Freddie Mac CEO Richard Syron for the companies' current problems. While both men are being removed as the top executives, they have been asked to remain for an unspecified period to help with the transition.

The problem is that each time they do something like this, the obligations of the already vastly overstretched U.S. government increase. In this takeover plan the U.S. Treasury will purchase mortgage securities.

U.S. Rescue Seen at Hand for 2 Mortgage Giants

Stephen Labaton and Andrew Ross Sorkin

September 6, 2008

WASHINGTON — Senior officials from the Bush administration and the Federal Reserve on Friday called in top executives of Fannie Mae and Freddie Mac, the mortgage finance giants, and told them that the government was preparing to place the two companies under federal control, officials and company executives briefed on the discussions said.

The plan, which would place the companies into a conservatorship, was outlined in separate meetings with the chief executives at the office of the companies’ new regulator. The executives were told that, under the plan, they and their boards would be replaced and shareholders would be virtually wiped out, but that the companies would be able to continue functioning with the government generally standing behind their debt, people briefed on the discussions said.

It is not possible to calculate the cost of any government bailout, but the huge potential liabilities of the companies could cost taxpayers tens of billions of dollars and make any rescue among the largest in the nation’s history.

The drastic effort follows the bailout this year of Bear Stearns, the investment bank, as government officials continue to grapple with how to stem the credit crisis and housing crisis that have hobbled the economy. With Bear Stearns, the government provided guarantees, and the bulk of its assets were transferred to JPMorgan Chase, leaving shareholders with a nominal amount.

Under a conservatorship, the common and preferred shares of Fannie and Freddie would be reduced to little or nothing, and any losses on mortgages they own or guarantee could be paid by taxpayers. Shareholders have already lost billions of dollars as the stocks have plunged more than 80 percent this year.

…The declines in the housing and financial markets apparently forced the administration’s hand. With foreign governments increasingly skittish about holding billions of dollars in securities issued by the companies, no sign that their losses will abate any time soon, and the inability of the companies to raise new capital, the administration apparently decided it would be better to act now rather than closer to the presidential election in two months.

Just five weeks ago, President Bush signed a law to give the administration the authority to inject billions of dollars into the companies through investments or loans. In proposing the legislation, Treasury Secretary Henry M. Paulson Jr. said that he had no plan to provide loans or investments, and that merely giving the government the authority to backstop the companies would provide a strong shot of confidence to the markets. But the thin capital reserves that have kept the two companies afloat have continued to erode as the housing market has steadily declined and the number of foreclosures has soared.

As their problems have deepened — and the marketplace has come to expect some sort of government rescue — both companies have found it difficult to raise new capital to absorb future losses. In recent weeks, Mr. Paulson has been reaching out to foreign governments that hold billions of dollars of Fannie and Freddie securities to reassure them that the United States stands behind the companies.

In issuing their quarterly financial statements last month, the two companies reported huge losses and predicted that home prices would fall more than previously projected.

The debt securities the companies issue to finance their operations are widely owned by mutual funds, pension funds, foreign governments and big companies…

The meetings reflected the reality that senior administration officials did not believe they could wait for some kind of financial tipping point, as happened with Bear Stearns, which was saved from insolvency in March by government intervention after its stock plummeted and lenders withheld their capital.

Instead, Mr. Paulson has struggled to navigate through potentially conflicting goals — stabilizing the financial markets, making mortgages more widely available in a tightening credit environment, and protecting taxpayers from possibly enormous losses…

It appears likely that Paulson’s ship will hit all three rocks. He can only stabilize the financial markets for so long. Who will to buy houses when values plummet and jobs are cut? And, the costs of all the bailouts will paid by taxpayers.

Signs of the Economic Apocalypse, 2-4-08

From SOTT.net:

Gold closed at 913.50 dollars an ounce Friday, up 0.3% from $910.70 for the week. The dollar closed at 0.6756 euros Friday, down 0.8% from 0.6811 at the close of the previous Friday. That put the euro at 1.4802 dollars compared to 1.4682 the Friday before. Gold in euros would be 617.15 euros an ounce, down 0.5% from 620.28 at the close of the previous Friday. Oil closed at 88.96 dollar a barrel Friday, down 2.0% from $90.71 for the week. Oil in euros would be 60.10 euros a barrel, down 2.8% from 61.78 at the close of the Friday before. The gold/oil ratio closed at 10.27, up 2.3% from 10.04 for the week. In U.S. stocks, the Dow closed at 12,743.19 Friday, up 4.4% from 12,207.17 at the close of the previous week. The NASDAQ closed at 2,413.36 Friday, up 3.7% from 2,326.20 at the end of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 3.59%, up four basis points from 3.55 for the week.

Since we throw around a lot of technical terms when discussing economic and financial matters, and in order to reduce mystification or obfuscation of the economy, a short glossary of terms might be helpful before discussing last week’s events.

Securities: Tradeable financial instruments, either debts (entitlements to the repayment, for example bonds) or equity (pieces of ownership, for example, stocks)

Inflation: When the price of goods goes up or the value of a currency goes down

Deflation: When the price of goods goes down or the value of a currency rises

Recession: Two conecutive quarters or more of negative economic growth

Depression: A severe or long recession

Economic Collapse: A severe or long depression

Currency Collapse: When a country’s currency drops to a fraction of what it was

Capital Flight: When investors pull their money out of a country

Stocks: Pieces (shares) of a company that can be bought or sold

Bonds: Instruments that can be traded carrying rights to repayment of debt

Yield: The percentage of interest on a debt instrument

Basis Points: Hundredths of a percentage point return on a debt instrument

Exchange Rates: The price of one currency in another currency

Revenues: A company’s income

Earnings: A company’s profit

GDP: Gross Domestic Product: The total value of a country’s goods

Correction: A ten percent drop in a market after a period of rising values

Dead Cat Bounce: When a market rises a little then falls again after crashing

Liquidity: Money (not necessarily cash, usually credit)


Last week little doubt remained that the United States is in recession with the news that the number of jobs fell.

U.S. Economy: Payrolls Fall for First Time Since 2003

Bob Willis

Feb. 1 (Bloomberg) -- The U.S. unexpectedly lost jobs for the first time in more than four years, increasing the odds the economy will fall into a recession and making it likely the Federal Reserve will cut interest rates another half point next month.

Payrolls fell by 17,000 in January after an 82,000 gain in December that was larger than initially reported, the Labor Department said today in Washington. None of the 80 economists surveyed by Bloomberg News predicted a decline.

Employment is one of the indicators, along with wages, production and sales, that help determine the start of economic contractions. The decline poses a further threat to consumer spending, which accounts for 70 percent of the economy, after households were already hurt by falling home and stock values.

“It is highly unusual for payrolls to fall except in a recession,” Christopher Low, chief economist at FTN Financial in New York, said in an interview. “The Fed will have to keep cutting rates and we can expect a cut at the next meeting in March.”

Fed Chairman Ben S. Bernanke and his colleagues said Jan. 30 “risks to growth remain” after cutting the benchmark rate by a half-point, eight days after an emergency three-quarter- point move. Odds of another half-point cut, to 2.5 percent, in March rose to 70 percent from 68 percent late yesterday, according to April futures quoted on the Chicago Board of Trade.

Treasuries Rally

Treasuries, which fell earlier in the day, rose after the report, with 10-year yields dropping to 3.60 percent at 5:13 p.m. in New York, from as high as 3.66 percent. Stocks rose on Microsoft Corp. $44.6 billion bid for Yahoo! Inc., with the Standard & Poor's 500 Index gaining 1.2 percent, at 1,395.42.

A private report today separately showed that manufacturing unexpectedly grew in January, showing business investment is holding up as other parts of the economy weaken. The Institute for Supply Management's index rose to 50.7, a five-month high, from 48.4 in December, the Tempe, Arizona-based group said.
Manufacturers, state governments and construction companies lost jobs, today's report showed.

“Employment fell across a broad assortment of industries,” said Mark Vitner, senior economist at Wachovia Corp. in Charlotte, North Carolina. “It raises a number of red flags for the economy. There is no question economic growth has slowed to a crawl and the risks of recession are significant. That is why the Fed has cut interest rates so aggressively.”

The jobless rate, which is based on a separate survey from the payrolls figures, declined to 4.9 percent in January from 5 percent the previous month.

…The economy expanded at a 0.6 percent annualized pace in the fourth quarter, government figures showed this week, and many economists anticipate a contraction in the current period.

“We are in or near a recession,” David Greenlaw, chief fixed-income economist at Morgan Stanley in New York, said in a Bloomberg Television interview. “We'll see the jobless rate begin to drift higher over coming months.”

If all we are facing is a recession than we will be very lucky. Chances are much worse is in store either depression or collapse. Why? For one thing, the U.S. dollar, the world’s reserve currency is in risk of collapse because to prevent banks from failing the Federal Reserve Board is rapidly lowering interest rates, but that, in turn, makes dollars worth less on the international currency market.

Here is Mike Whitney on the banking crisis:

Rate Cut as Dagger
America's Teetering Banking System

Mike Whitney

January 31, 2008

Somebody goofed. When Fed chairman Ben Bernanke cut interest rates to 3 per cent yesterday, the price of a new mortgage went up. How does that help the flagging housing industry?

About an hour after Bernanke made the announcement that the Fed Funds rate would be cut by 50 basis points the yield on the 30-year Treasury nudged up a tenth of a percent to 4.42 per cent. The same thing happened to the 10 year Treasury which went from a low of 3.28 per cent to 3.73 per cent in less than a week. That means that mortgages, which are priced off long-term government bonds, will be going up too.

Is that what Bernanke had in mind; to stick another dagger into the already-moribund real estate market?

The Fed sets short-term interest rates (the Fed Funds rate) but long-term rates are market-driven. So, when investors see slow growth and inflationary pressures building up; long-term rates start to rise.

Bernanke knew that the price of a mortgage would increase if he slashed rates, but went ahead anyway.

How did he know?

Because 8 days ago, when he cut rates by 75 basis points, the ten-year didn't budge from its perch at 3.64 per cent. It just shrugged it off the cuts as meaningless. But a couple days later, when Congress passed Bush's $150 stimulus package, the ten year spiked with a vengeance, up 20 basis points on the day. In other words, the bond market doesn't like inflation-generating government handouts. So, why did Bernanke cut rates when he knew it would just add to the housing woes?

The fact is, Bernanke had no choice. He's facing a challenge so huge and potentially catastrophic; that cutting rates must have seemed like the only option he had. The banks are "capital impaired" and borrowing at a rate unprecedented in history.

The capital that the banks do have is quickly being depleted.

Banks are forced to borrow reserves from the Fed in order to keep lending.
A careful review of these graphs should convince even the hardened skeptic that the banking system is basically underwater. The sudden and shocking depletion of bank reserves is due to the huge losses inflicted by the meltdown in subprime loans and other similar structured investments.

"When US homeowners default on their mortgages en-mass, they destroy money faster than the Fed can replace it through normal channels. The result is a liquidity crisis which deflates asset prices and reduces monetized wealth," says economist Henry Liu.

The debt-securitization process is in a state of collapse. The market for structured investments -- MBSs, CDOs, and Commercial Paper -- has evaporated, leaving the banks with astronomical losses. They are incapable of rolling over their short-term debt or finding new revenue streams to buoy them through the hard times ahead. As the foreclosure-avalanche intensifies; bank collateral continues to be down-graded which is likely to trigger bank failures.

Henry Liu sums it up like this: "Proposed government plans to bail out distressed home owners can slow down the destruction of money, but it would shift the destruction of money as expressed by falling home prices to the destruction of wealth through inflation masking falling home value." ("The Road to Hyperinflation", Henry Liu, Asia Times) It's a vicious cycle. The Fed is caught between the dual millstones of hyperinflation and mass defaults.

The pace at which money is currently being destroyed will greatly accelerate as trillions of dollars in derivatives are consumed in the flames of a falling market. As GDP shrinks from diminishing liquidity, the Fed will have to create more credit and the government will have to provide more fiscal stimulus. But in a deflationary environment; public attitudes towards spending quickly change and the pool of worthy loan applicants dries up. Even at 0 per cent interest rates, Bernanke will be stymied by the unwillingness of under-capitalized banks to lend or over-extended consumers to borrow. He'll be frustrated in his effort to restart the sluggish consumer economy or stop the downward spiral. In fact, the slowdown has already begun and the trend is probably irreversible.

The financial markets are deteriorating at a faster pace than anyone could have imagined. Mega-billion dollar private equity deals have either been shelved or are unable to refinance. Asset-backed Commercial Paper (short-term notes backed by sketchy mortgage-backed collateral) has shrunk by $400 billion (one-third) since August. Also, the market for corporate bonds has fallen off a cliff in a matter of months. According to the Wall Street Journal, a paltry $850 million in high-yield debt has been issued for January, while in January 2007 that figure was $8.5 billion---ten times bigger. That's a hefty loss of revenue for the banks. How will they make it up?

Judging by the Fed's graphs; they won't!

Bernanke's rate cuts sent stocks climbing on Wall Street, yesterday, but by early afternoon the rally fizzled on news that Financial Guaranty, one of the nation's biggest bond insurers, would be downgraded. The Dow lost 37 points by the closing bell.

The plight of other major bond insurers, MBIA and Ambac, could be known as early as today, but it is reasonable to expect that they will lose their Triple A rating. According to Bloomberg:

"MBIA Inc, the world's largest bond insurer, posted its biggest-ever quarterly loss and said it is considering new ways to raise capital after a slump in the value of subprime-mortgage securities the company guarantee". The insurer lost $2.3 billion in the fourth-quarter. Its downgrading from AAA will "cripple its business and throw ratings on $652 billion of debt into doubt." Many of the investment banks have assets that will get a haircut.

The New York State Insurance Department tried to work out a bailout plan but the banks could not agree on the terms (ed note: "They don't have the money")
"Bond insurers guarantee $2.4 trillion of debt combined and are sitting on losses of as much as $41 billion, according to JPMorgan Chase & Co. analysts. Their downgrades could force banks to write down $70 billion, Oppenheimer & Co. analyst Meredith Whitney said yesterday in a report." (Bloomberg)

The bond insurers were working the same scam as the investment banks. They found a loophole in the law that allowed them to deal in the risky world of derivatives; and they dove in headfirst. They set up shell companies called "transformers", (the same way the investment banks established SIVs; structured investment vehicles) which they use as "off balance" sheets operations where they sell "credit default swaps , which are derivative instruments where one party, for a fee, assumes the risk that a bond or loan will go bad". ("The Bond Transformers", Wall Street Journal) The bond insurers have written about $100 billion of these swaps in the last few years. Now they're all blowing up at once.

Credit default swaps (CDS) have turned out to be a gold-mine for the bond insurers and they've given a boost to the banks too, by freeing up capital they use in other ventures. "The banks profited on the interest rate difference between the CDOs (collateralized debt obligations) they bought and the payments they made to transformers...The banks sometimes booked profits upfront on the streams of income they expected to receive." (WSJ)

Neat trick, eh?

Even now that the whole swindle is beginning to unravel, and tens of billions of dollars are headed for the shredder; industry spokesmen still praise credit default swaps as "financial innovation".

"It's too early to say we're going to ban all these products," said Guenther Ruch, administrator for Wisconsin's insurance regulation and enforcement division. (WSJ)

Maybe Ruch is right. Maybe it is too early to ban all these dicey financial inventions. But he may change his tune when Wall Street gets a whiff of the billions that'll be lost in downgrades and the markets start to tumble.

Other countries that have indulged in “financial innovation” while enjoying an asset bubble like the United States are in for nasty surprises as well. The U.K. is now bracing for a million foreclosures:

Warning over one million homes at risk

Economic slowdown would leave many borrowers vulnerable, says FSA

Jill Treanor

The Guardian

Wednesday January 30 2008

More than a million homeowners could be at risk of serious financial difficulty and possibly losing their homes in an economic slowdown, the City regulator warned yesterday.

The Financial Services Authority is preparing for a tougher climate of rising inflation and a slower economy. It fears that many homeowners with large mortgages who have borrowed three and a half times their salaries or more could be at risk.

The warning comes as surveyors predict today that 123 homes a day will be repossessed this year. The FSA cites three warning signs on mortgages:

· The loan was taken out for longer than 25 years;
· It is worth more than 90% of the home;
· The amount borrowed is 3.5 times or greater than income .

Over a third of all mortgages sold between April 2005 and September 2007 fall into one or more of these categories. This suggests that more than 2m of the 5.7m mortgages written during this period are of potential concern.

It is the 1.04m customers whose mortgages contain two or more characteristics who most concern the FSA. It calculates that the number "most likely to default on loans" - those whose mortgage falls into all three categories - is 150,000.

The regulator is concerned that many borrowers are badly prepared for worsening economic conditions. It believes homeowners may have become too reliant on cheap credit and rising house prices to sustain levels of spending.

The FSA's concerns are based on the current economic climate deteriorating and an end to the easy credit available to many customers over the past two years.

A "significant minority" of customers could find their finances become very tight if lenders react to any worsening in financial conditions by cutting the number of mortgages they are prepared to sell.

The pressure on homeowners may not be eased by cuts in official interest rates either. The Bank of England is expected to sanction another cut next week - on top of its quarter point reduction in December. But the FSA admitted it was "not clear" whether the reduction would be passed on by the mortgage lenders, whom it notes could actually raise rates to deal with the pressures on their business.

Lyndon Nelson, the FSA's head of financial strategy and risk, said: "It is not necessarily the affordability of the mortgage. It is their other debt. Customers with other borrowing in addition to the mortgage are struggling."

"The other borrowings tip them over the edge," he said.

This could have repercussions for the wider economy if house prices start to ease and other spending slows.

The warning comes in the FSA's Financial Risk Outlook, which it uses to describe the risks it sees over the next 18 months. The regulator notes that the new loans were "concentrated in groups which historically have not been homeowners" which could make it difficult for lenders to predict how they will behave.

The FSA also points out that the level of repossessions is still relatively low, but believes they will rise. This is borne out by the Royal Institution of Chartered Surveyors, which today predicts about 123 homes a day will be repossessed this year.

The FSA has already sounded the alarm over 1.4m fixed-rate mortgages which are due to mature in the next 12 months and has warned mortgage lenders not to rush into repossessions.

The warning is just one of the "priority" risks it has identified for the next 18 months. The others include customers losing confidence in another financial firm, in the way they did with Northern Rock; concerns about the business models of some banks since the credit markets tightened; and a potential increase in finance crime caused by the downturn.